Fixed Income Class Notes Chapter 7

Fixed Income Class Notes Chapter 7 - buckets While key rate...

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Fixed Income Class Notes Chapter 7 – 11/3/11 Key rates techniques - assumes that given certain key rates, any other rate may be determined. An analyst must choose the number of key rates, the type of rate to be used, terms of the key rates, and the rule for computing all other rates given the key rates used. Each region of the par yield curve is affected by a combination of the key rates closest to it. Review table 7.1 Key rate exposures. A hedged portfolio will be approximately immune to any combination of key rate movements. The quality of a hedge position deteriorates as the size of the interest rate change increases. A hedge only works if the par yields between key rates move as assumed. The greater the number of key rates, the better the quality of the resulting hedge. A bucket is a region of some curve, or a term structure of interest rates. Bucket analysis usually uses many
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Unformatted text preview: buckets While key rate analysis tends to use a relatively small number of key rates. Each bucket shift is a parallel shift of forward rates as opposed to the shapes of the key rates Swaps are agreements to receive or pay fixed cash flows for a particular set of terms. They can be executed at very low bid-ask spreads, but can be very costly to unwind. The practice of accumulating swaps leads to large portfolios that change in composition very slowly. Immunization – holding a portfolio of assets with cash flows that exactly offset the company’s future expected liabilities. Feasibility of immunization depends on the circumstances, one extreme is hedges that protect against parallel shifts, other extreme is bucket exposures....
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